Interest Rates Are Dropping, Marking a Pivotal Year for Banking

The Macroeconomic Picture

The U.S. economy is expected to experience a significant slowdown in 2025, with GDP growth forecasted at 1.5% in Deloitte’s baseline scenario, down from an estimated 2.7% in 2024. This deceleration comes as consumer spending moderates and unemployment inches higher. While a recession appears unlikely, there remains a small probability that growth could slow to just 1% if inflation proves stubborn and geopolitical tensions escalate.

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The strength of American consumers — who have been a crucial driver of economic growth — will face a more serious test in 2025. Consumer debt has reached an unprecedented $17.7 trillion, and pandemic-era excess savings were depleted by March 2024. These factors, combined with potentially weaker employment conditions, could significantly impact consumer spending patterns and loan demand.

Perhaps one of the biggest drivers of these trends comes down to the decisions happening in the Federal Reserve, which is expected to cut interest rates three to four times in 2025 — particularly as inflation approaches the 2% target. These cuts would bring the federal funds rate to between 350 and 375 basis points. The yield curve — which has been inverted for nearly two and a half years — may finally normalize as short-term yields fall faster than long-term rates.

Learn more about hot trends in banking’s future in 2025:

Deposit and Revenue Challenges

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Banks face a complex deposit environment in 2025. Even as rates decline, funding costs may not decrease proportionally. Industry analysts project deposit costs to remain elevated at 2.03%, significantly above the previous five-year average of 0.9%. This dynamic could compress net interest margins to around 3% by year-end.

On the other hand, loan demand could vary. Mortgage activity might increase as rates drop, but consumer loans will more likely than not see sluggish growth due to financial pressures on households. Corporate borrowing is anticipated to remain stable, with potential upticks in debt issuance and M&A activity if economic uncertainty subsides.

As interest income faces pressure, banks are likely to focus more on fee-based revenue streams. Investment banking could see renewed strength from increased M&A activity and debt issuance. Some institutions are already seeking higher fees for services like fairness opinions and deal-related advisory work.

Wealth management presents another growth opportunity, though firms must navigate fee compression and increasing competition. Banks are expanding their wealth management offerings beyond traditional investment advice to include services like tax planning, estate planning and long-term care guidance. The market remains underpenetrated, with top banks holding only about 32% of the total wealth management market globally.

Payment processing and card revenues face both opportunities and challenges. While transaction volumes continue to grow, margins are under pressure from technological disruption and regulatory scrutiny. Banks are responding by developing new revenue streams through value-added services and expanding into emerging payment channels.

Credit Quality and Risk Management

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Credit quality is expected to normalize in 2025, with delinquencies and charge-offs increasing modestly from 2024 levels. Consumer loans, particularly credit cards and auto loans, may see rising delinquencies as household finances come under pressure. Credit card loans already show the highest 90+ day delinquency rate among all loan categories at 1.69%.

The commercial real estate sector remains a significant concern, especially for regional banks. Properties in the office segment face particular challenges due to changing work patterns post-pandemic. Banks with assets between $10 billion and $100 billion have the highest commercial real estate exposure relative to risk-based capital at 199%, compared to just 54% for banks with assets exceeding $250 billion.

Banks are accelerating their technology investments, particularly in artificial intelligence and core system modernization. According to industry research, AI could boost global banking industry profits by 9% over the next five years, potentially reaching $2 trillion by 2028.

However, many institutions face challenges in scaling their AI initiatives. Only about one-quarter of banking respondents in a recent survey indicated their data management platforms are highly prepared to adopt generative AI tools. Technical debt and legacy infrastructure continue to pose significant barriers to technological advancement.

Cloud migration represents another critical technology priority. Banks are increasingly adopting a financial operations approach to manage cloud costs while maximizing returns on their investments. This includes tracking unused resources, identifying commitment-based discounts and determining when resources should be moved back on-premises.